Monday, August 31, 2009

* MARKET THEMES FROM MONDAY: We saw an early decline in stocks break us below the lows of 8/27, only for trade to slow down considerably and then rally late in the session. Short-term, this leaves us in a trading range between the overnight highs preceding Monday's trade and Monday's lows. Overall, weakness dominated with market, with about 1400 more declining issues than advancers on the NYSE and 20-day lows exceeding new highs. The U.S. dollar weakened once we hit a bottom in stocks; gold strengthened from that point, but oil remained relatively weak through the session. Financial stocks closed well off their highs and well into Friday's trading range; industrial stocks, small caps, and consumer discretionary shares were relatively weak from the open. Ten-year rates closed near their lows, just a bit above 3.4%.

Above we see the S&P 500 e-mini futures (ES) on an hourly chart, illustrating the recent choppy, sideways action. If you click on the chart and look at the blue numbers above the volume bars, you'll see how the 20-day new highs (top number) and lows (bottom number) have shifted downward over this period. Indeed, we saw more new 20-day lows than highs today, a sign of deterioration in the broad stock market. This fits with my earlier view of the indicator, suggesting a narrowing base to the bull market.

Note: This indicator tracks all common stocks across the NYSE, NASDAQ, and ASE and is updated each morning before the market open via Twitter; follow here)..

With China (FXI; top chart) well off its early August highs, note the relative weakness of Basic Materials companies today and on a one-week basis per the excellent FinViz site. If growth in China is slowing down, demand for raw materials should weaken--and that puts a drag on a sector has been a leader since the March stock market lows..

After a high-volume decline early in the morning, note how the market has since slowed down and drifted into a range just above the lows from 8/27. When we see relatively high volume (i.e., volume that is above average for that particular time of day) turn into relatively low volume (volume that is subnormal), it suggests that institutional traders have largely withdrawn from the marketplace. That leaves the market to the relative control of short-term market makers, including algorithmic programs operating close to the market. That can give the market trendless choppy action that is difficult to trade.

It is not unusual to see large traders stand back from the market the day before an important economic release or event, such as a Fed announcement. In this case, traders are looking ahead to the ISM release tomorrow morning. There is a wide range of expectations for the number, ranging from slightly below 50 (economy contracting) to nicely above 50 (economy expanding). Not wanting to get run over by a number outside of consensus, it's not surprising that money managers pull in their horns ahead of the release.

When that happens, we can generally anticipate an active trade after the event or release, as money managers jump back into the market and respond both to the news and how markets are responding to the news..

Sometimes it feels as though it's all just one trade: the market is either rewarding risky assets or shunning them. Indeed, tracking intermarket themes during and across days provides useful information regarding the sentiment of large money managers.

I took a quick look at how three markets have been correlated since mid-2007 in terms of their weekly returns: U.S. dollar (UUP); commodities (DBC); and stocks (SPY).

If anything, correlations have tightened up a bit during 2009. The negative relationship between the dollar and commodities makes sense, since commodities are in part denominated in dollars. A weak dollar implies a reflationary/inflationary outlook, which is positive for commodities.

As economies have picked up, the expectation is that economic growth would lead to greater commodity consumption; hence the positive correlation between commodities and stocks.

During the bear market, the U.S. dollar acted as a safe haven; those selling risky assets such as stocks fled to the safety of Treasury instruments and dollars. Now that stocks have been on the rise in the wake of economic recovery, there has been an appetite away from the dollar and toward the currencies of faster growing areas. Hence the negative correlation between the dollar and stocks.

An additional useful correlation to follow is Treasury yields. By observing the ebb and flow of these correlations over time, we gain insight into intermarket themes that drive capital flows..

* When, if at all, to add to your positions or start scaling out of them;

* When, if at all, to hedge positions.

I generally have found that, especially among portfolio managers, trade management accounts for as much profitability as the quality of the initial trade ideas. I also find that, among proprietary daytraders, much money is lost through poor trade management, as traders add to positions at the wrong times or scale out of them too quickly.

The importance of trade management comes from the flow of information that occurs *while the trade is on*. If you're attuned to that information, it can help you decide whether to become more or less aggressive over time by moving stops and targets and/or scaling in/out of positions by adjusting your size.

If you think of your trade as a test of your market hypothesis, you constantly want to be thinking about whether the most recent market action is confirming or disconfirming your expectations. It is when you're right and see that the market is proving you right that you can best press your advantage.

I find it is particularly helpful to have explicit rules to aid trade management. I will offer a few of my own in the Wednesday seminar and in future posts..

I recently wrote on the topic of how daytrading was offering limited opportunity sets, particularly for those who have been trading the stock market indexes. The reason for this is that an increasing proportion of total index movement has been initiated overseas. Those who close their positions out by the end of the day find themselves missing nice market moves that they might have seen coming.

Indeed, many of the daytraders who I work with and hear from who are doing well this year are not trading the indexes. Instead, they have found creative ways of finding stocks and sectors that offer excellent intraday movement, trends, and reversals.

Readers are aware that, each morning before the market open, I publish proprietary daily price targets for the S&P 500 Index (SPY). These are volatility adjusted, so that expectations of movement reflect the recent volatility of the market. Each day there is a pivot level, which is an approximation of the day's average trading price and there are three upside targets (R1, R2, R3) and three downside targets (S1, S2, S3). Going back to the year 2000, we find that about 70% of all trading days touch their prior day's pivot; 70% will touch R1 or S1; 50% will hit R2 or S2; and 33% will reach R3 or S3. (Follow the Twitter stream here for profit target numbers and other indicators and alerts).

I have reconfigured weekly pivot levels with research going back to 2000 so that the numbers are analogous with the daily figures. The pivot level is an estimate of the average trading level of the prior week; R1/R2/R3 and S1/S2/S3 are the upside and downside targets. The odds of hitting the weekly targets are very similar to those for the daily targets.

I use these weekly figures very similarly to the daily ones in framing targets for trades. For example, I mentioned on Friday that I had established a small short position in the S&P 500 Index after we rejected an effort to make new price highs amidst numerous divergences. With an entry of 103.19 on this swing trade, I'm looking for a move to at least 100.63, which would put us back into the early August trading range.

So what is my stop loss point? On Friday, I determined that I would stop out if we made new price highs. That put the stop at 104.35. Note that today's R1 level is 104.24. If we are indeed going to be heading lower, we should not be taking out R1 today. That means that the day's R1 level acts as a natural stop loss for the trade conceptualized on the swing time frame. That also means that my trade targeting (at minimum) the weekly S1 and stopping out at the daily R1 has a favorable risk/reward profile.

Thus far the trade has moved my way; note how I would have lost a nice piece of movement had I waited until the next day to execute my idea as a daytrade. To be sure, swing trades will carry a higher volatility of returns than trades executed on a day timeframe; the way to adjust for that volatility is simply to size swing trades smaller than day ones, so that too much of your portfolio is not exposed to the higher risk of the longer holding period. This is a far better strategy than placing stops too close to entry points.

With the daily and weekly levels, I find that I have a rational basis for placing stops and targets, and that helps me stick to those. Starting next week, I will be posting the weekly SPY price targets before the Monday open via Twitter..

Sunday, August 30, 2009

* MARKET THEMES FROM FRIDAY: We saw stocks make a marginal new bull market high early in morning trade before selling off hard in the morning and rebounding weakly in the afternoon. The rejection of the price highs, combined with the divergences at the market peak, led me to take a small short position in the S&P 500 Index and hold it over the weekend. This is not intended as a short-term trade (but does have a relatively tight stop); I will be blogging about the position early this coming week. With the drop in stocks, we also saw firming of the U.S. dollar and some selling in oil and gold, though the latter was not especially pronounced. In premarket trade, Japan started its day higher on the election news, but stock index futures in the U.S. have pulled back from early strength. A move below Friday's lows would target the 8/27 lows around 1015 in the ES contract.

I recently noted that I will be offering a free webinar this week sponsored by the Institute of Auction Market Theory (IOAMT). The session will indeed be held this Wednesday, September 2nd, after the market close at 3:30 PM Central Time. The session will focus on specific psychological self-help techniques that traders can use for themselves to aid their performance. It will be an hour long session with time for Q&A.

There is a 500-person limit for registration; I'm pretty sure this will fill up quickly. So, if you can make it and are interested, please take the time to register at this site.

I also notice that IOAMT is offering a $50 discount for webinar attendees who would like to attend their upcoming week-long workshop. They also offer a five-day free trial to their real time trading room, where Bill Duryea tracks markets and posts his trades, illustrating the use of Market Profile theory and technique.

Hope to see you at the webinar!If you can't make it, I'm told that IOAMT will be archiving the session and posting a link shortly afterward. Many thanks to Bill and Michelle for helping put this together..

Last week's sector update emphasized the short-term trending strength across all sectors, but also noted divergences with respect to the number of stocks registering new highs. I expected that divergence to be resolved one way or another this past week, but the situation is very much the same: Technical Strength (a proprietary short-term measure of trending) remains positive across sectors, but the market's strength is built upon a narrowing base.

As we can see from the chart above, all eight major S&P 500 sectors that I follow are trading in short-term uptrends, though readings for the most part are weaker than they were at last reading. The economically sensitive industrial, energy, and consumer discretionary sectors are notably strong; the more defensive health care and consumer staples groups are weaker. Interestingly, we're seeing less bullish movement among raw materials stocks, reflecting continuing non-confirmations of stock market highs among such commodities as oil and industrial metals.

At last reading (which I update each morning before the market open via Twitter; follow here), 30 stocks in my basket were trading in short-term uptrends, 10 were neutral, and none were trading in downtrends. It is only if we see the non-trending stocks converting to downtrends and some of those in uptrends downshifting to neutral that I would be aggressive in acting upon the persistent divergences in the market. Thus far the market has been managing to make fresh price highs week over week, and we need to respect that, even as we keep an open mind to the possibilities of reversal..

TRIN appeared to be broken because we were getting huge swings in its values from moment to moment in the market. It would swing wildly, sometimes going far above 1.0 and sometimes far below. I pointed out that, from a purely mathematical vantage point, this could only occur if a disproportionate share of NYSE volume was occurring in one or a handful of stocks.

Further inquiry revealed that this was, indeed, the case: I found that, not only were the trading volumes of such stocks as C, AIG, FNM, and FRE elevated, as noted the by Big Picture blog, but that their composite volumes (their volumes traded across all exchanges) exceeded that of all other NYSE stock trading! Indeed, I discovered that the 20-day TRIN was at its lowest level since 2000 because volume was highly concentrated in rising stocks. This was not just unusually heavy volume; it was unusually heavy to the buy side.

Since this volume was directional--all of these stocks had made spectacular percentage gains--and because the highly unusual activity was unique to troubled financial firms (not stable companies such as GS and JPM), I surmised that something might be afoot: a systematic attempt to bolster the shares of taxpayer supported companies that--for political reasons--could not return to the bailout well. Why such an attempt? Perhaps to reimburse the largest shareholder of the institutions and position these companies to raise capital on their own. They certainly weren't going to raise their own capital as languishing two-dollar zombie stocks.

Of late, we've seen articles in the mainstream media suggesting that the volatility in these troubled financial companies' shares is attributable to short-covering. "When large numbers of short sellers close their positions by buying shares at the same time, the stocks involved can register explosive - and often inexplicable - gains," the Financial Times article explains.

Once we look at the magnitude of the recent activity in these stocks, however, the idea that this rise is largely a function of short covering becomes implausible. As we see with Citigroup (C) stock (top chart) and AIG, FNM, and FRE (bottom chart), the August trading volume alone has exceeded the total floats of these companies--and certainly their total short interests--by factors of 4 or more. While short covering no doubt has contributed to the rise in these shares, traders and investors could have covered every single short position and still not accounted for the lion's share of recent activity in the stocks.

We also hear the idea from the mainstream media that some of the huge volumes in these stocks can be attributed to "daytraders". This conjures images of young guys in proprietary trading shops churning trades all day long. I know or work with a number of the largest discretionary prop firms in the country and am aware of none with the capitalization to pull off trading volumes of this magnitude. It boggles the imagination that, suddenly in August, daytraders across the country began trading volumes of shares in excess of total NYSE volume. Again, I have no doubt that daytraders have been playing these stocks and contributing to their rally; I just cannot see them as primary drivers of such activity.

The fact that the August trading volumes in C, AIG, FNM, and FRE far exceed their total floats also suggests that individual large buyers of these companies are not driving their rise. To achieve volumes of this staggering magnitude, some kind of churning of shares must be occurring--not just block purchases over time. The only kind of trading technology I know of that is capable of such churning is high frequency, algorithmic trading. This was also the recent conclusion of Zero Hedge. Firms engaging in such strategies, including some of the largest investment banks, do indeed have the capital to trade such volumes.

Of course, these high frequency trading programs are supposed to be market making only, not drivers of directional market moves. As a federal prosecutor noted when there was an alleged theft of some of these programs, however, such technology can "manipulate markets in unfair ways".

Are these bailout beneficiaries now enjoying the fruits of market manipulations? I don't know the answer to that, but I find it interesting that none of the principals of the firms appears to care. According to a recent article, the chair of Freddie Mac indicated that he had "no idea" what these trading volumes were all about. The article also noted that, "Representatives for Fannie, the SEC, AIG, FINRA and the NYSE declined to comment. Spokeswomen for Treasury, which owns most of AIG, and the Federal Housing Finance Agency, which holds Fannie and Freddie in conservatorship, also wouldn't comment."

Somehow I think if the tables were turned and huge volumes were being executed on the *short* side to drop the share values of these companies, we would hear a renewed hue and cry about manipulated markets and the need to curb rapacious short sellers. When there is unprecedented volume lifting the shares of seemingly worthless companies in a manner that could only be accomplished by the directional programming of trading systems, company officials and financial regulators appear to be silent lambs.

I don't have answers to many of these puzzling observations; I do recognize good questions worthy of inquiry. If we're not getting comment from authorities and the firms themselves, where is the investigative financial press? Bland assurances that we're merely seeing heightened short covering and daytrading activity simply don't pass muster.

The chart above tracks the number of NYSE, NASDAQ, and ASE stocks making fresh 20-day highs minus the number making new 20-day lows (red line).

Note that new highs peaked in late July in what appears to be a momentum high. At the recent price highs (SPY; blue line), we are seeing fewer stocks participating in the new highs. If this candidate transition pattern holds, we should eventually take out the August lows in SPY. (Note: I follow this and other indicators each morning before the market open via Twitter; follow/subscribe here).

I just wanted to add some color to my recent post regarding why the NYSE TRIN indicator might be broken. Reader Brian adds a very interesting perspective, indicating that he's watched TRIN and C side by side and has seen a very strong correlation. When C flips from up to down (or vice versa), there is a corresponding huge move in TRIN. This could only be the case if a stock like C comprised a large share of total NYSE volume, which indeed seems to be the case, as noted by The Big Picture blog.

Above I took C, FNM, and FRE and expressed their *composite* volumes (e.g., the volumes transacted across all exchanges) as a fraction of NYSE volume. What we see is that, early in 2007, those three stocks accounted for only 1-3% of NYSE volume. During the financial crisis of late 2008 and again as the market was bottoming in early 2009, that ratio skyrocked to well over 50%.

Recently, however, the volume in these three stocks has hit astronomical levels relative to total NYSE trading, as all three have made phenomenal percentage gains during August. Indeed, the composite volume of these three stocks alone has recently doubled total NYSE volume. If we look at just the NYSE trading of these firms, they are accounting for about 40% of NYSE volume. It is not surprising that Brian would notice TRIN flipping up and down as these stocks change direction.

Again, the question is what all this means. There is no way that mom and pop trader and investor are involved in any meaningful way in generating these kind of daily trading volumes. Nor are proprietary trading shops capable of generating volumes that exceed those of the entire New York Stock Exchange. While I have no doubt that the algorithmic trade close to the market is participating in this movement, the directionality of the involvement suggests that large financial institutions are systematically buying the beaten-up shares of the poster children for TARP: C, FNM, FRE, AIG, and the like.

It is worth noting in this regard that other major (healthy) financial firms, such as GS and JPM, have seen no such surge in their volume or their trading prices.

My best guess? We're seeing a massive infusion of capital into very troubled financial institutions, no doubt aided by short covering and the participation of program traders and proprietary daytrading firms. Where is the capital coming from? Why has it poured in so suddenly (the really large infusions began in early August)? Why is it coming in at such a pace that it is dominating NYSE volume? Zero Hedge rightly wonders why this hasn't triggered alarms at the exchange. And why is it happening with only the weakest financial institutions?

If you were the government and you saw that these institutions were on the verge of a major fail, with billions of taxpayer dollars at risk, I'm not sure you'd announce that to the world. Nor, at this point politically, could you ask for yet another bailout package. But you would only pour money into those stocks at a frantic pace (capable of detection) if you perceived a dire need for the capital.

I'm not inclined toward conspiracy theories, but it's difficult to imagine a scenario in which this is not a (frighteningly necessary) coordinated capital infusion, with taxpayer dollars ultimately at work in financial markets..

Friday, August 28, 2009

A few readers have asked this question, noting recent low TRIN values. (TRIN is also known as the ARMS Index). Of course, what this means is that a high proportion of daily trading volume has been concentrated in rising stocks.

But is TRIN low?

To address this, I looked at the median 20-day TRIN values going back to 2000. I used the median because the TRIN ratio is constructed in such a way that you can get much larger readings above 1.0 than below. With the median, I wanted to capture whether the average day was showing greater concentration of volume to the winning or losing stocks.

Guess what? The current 20-day median TRIN is the lowest value we've seen since 2000 at around .75.

I'm not exactly sure what to make of that. What I can tell you with certainty is that two of the past historical occasions in which we've had 20-day price highs and ultra low median 20-day TRIN readings have been March, 2000 and late May/early June, 2007. Both corresponded more or less to bull market peaks.

The ultra low TRIN seemed to capture frothiness in those markets: lots of volume going into a few speculative, rising issues. Might we be seeing the same thing with the recent pops in such low priced stocks as AIG, C, FNM, FRE, CIT, and BAC? I note that about 2 billion of NYSE volume was concentrated in C, FNM, and FRE alone. Seems like lots of money chasing low-priced volatile financial stocks.

Just like lots of money chasing volatile tech stocks or emerging market stocks. Not something you'd see at market bottoms. A bit of a sentiment caveat for this market shrink..

2:10 PM CT - I've added the Market Delta chart above to show how we are building volume at lower price levels during the afternoon, accepting value below the day's VWAP. As long as that remains the case, I'd be looking for an eventual test of the Thursday lows. I have a small pioneer short position in the S&P that I'll be blogging about later.

The bulls just aren't feelin' it. I show that we've made about 1000 new 20-day highs across the NYSE, NASDAQ, and ASE on a day where ES (chart above) moved to marginal bull highs. The rally just keeps thinning out in terms of participation: non-confirmations, from emerging markets to commodities, continue to abound.

We sold off sharply following the early strength and, since then, volume at the market bid (bottom histogram) has swamped volume at the offer. We've also moved convincingly below VWAP (red line) and the volume bulge around 1030 (side histogram).

This sets us up in a very distinctive range between the lows that we rejected yesterday and the highs that we've rejected today. The weakening participation concerns me; I'm a seller on strength as long as bounces cannot take/keep us above VWAP and that 1030 level..

As Dave Kansas points out in his recent article, stock dividends do make a difference, particularly when other forms of yield--such as Treasuries--are offering paltry returns. Dave makes the excellent point that dividends are typically taxed at lower rates than bond income, which could help support the prices of higher-yielding equities.

Of the sectors tracked by FinViz (click above), utilities show up with the highest yields. While they may not be sexy for their beta (they're up around 30% for the past six months vs. 50% for many of the other sectors), they may find nice floors as those nearing retirement seek relatively safe yield..

Yesterday we saw stocks (ES futures, top chart) try to make new multiday lows, only to snap back into their range. Today we see the reverse, as an attempt to take out the highs from 8/25 was firmly rejected on aggressive selling (bottom chart). As is generally the case, the inability to sustain the new highs targeted the day's VWAP as an initial downside objective and the midpoint of the multiday range as a more distant objective. Stock sectors are uniformly down from their opening prices, indicating breadth to the rejection of higher prices. First half hour volume came in at pretty average levels; I'll be watching for signs of a slowdown in volume to handicap the odds of staying in the overnight range (vs. breaking down further into the multiday range)..

I sometimes hear reluctance from traders to wade into currency markets because they don't offer the same kind of volume information that we find in stocks. While that may be true for the spot market, currency futures trade in such a correlated way with their cash counterparts--and have picked up sufficient trader interest--that they can be viewed just like any futures market.

Above I've taken my Market Delta ES chart definition and simply inserted EUR/USD e-mini futures (6E). This is showing us early morning trade with 30-minute bars. Note how we are building volume (accepting value) at higher prices during the morning (side histogram), with fairly evenly distributed volume at the bid vs. offer (bottom histogram). So far, we've been oscillating around VWAP (red line) in a trading range.

Note the transition pattern early in the morning, as we had a drop to momentum lows on strong selling that then dried up over the next hour, giving us a price low, and then a reversal. A not dissimilar reversal occurred later in the morning, leading me to conclude that the market is shutting off trade to the downside and facilitating trade higher. That, of course, has implications for stocks, as it was the weak dollar that kicked off yesterday's reversal of weakness. Continued weakness in the dollar (e.g., euro strength) is currently supporting stocks in premarket trade..

Thursday, August 27, 2009

* MARKET THEMES FOR THURSDAY: Early weakness led to a breakout below recent multiday highs, before notable weakness in USD led a rally in risk assets, with rebound strength in gold, oil, and stocks. It was yet another instance in which weakness was stopped dead in its tracks by aggressive buying, creating a distinctive price rejection. We saw only 739 20-day highs against 348 lows, and momentum continued to be skewed to the downside, with Supply exceeding Demand. (I will post the final numbers tomorrow before the open via Twitter; follow here). The ability of the market to trade back into the multiday trading range and shut off selling suggests that we may be seeing another one of those relatively flat corrective periods that typically precedes new price highs in a bull market. A sustained drop below today's lows would clearly negate that scenario.

Gold (GLD; daily chart above) has shown quite the compressed trading range since the early 2009 stock lows, frustrating bulls and bears alike. It's on my longer-term watchlist as a breakout candidate, particularly if we continue to sustain weakness in USD. As a surrogate currency and possible beneficiary of a reflationary/inflationary outlook, gold could become quite a story on a break above $1000/oz..

Another nice graphic from FinViz: Note how, among the actively traded currencies, the market recovery has been led by New Zealand and Australia vs. the U.S. dollar (top chart). The currencies of the resource producing countries, as a whole, have fared better than those of the resource consumers; countries most affected by economic crisis and rising debt levels have also seen their currencies lag.

But it turns out that AUD/USD is not a bad proxy for risk appetite in the recent market. If you note the second chart from the bottom, you'll see that AUD dropped precipitously during the market crisis, as investors sought the safe haven of USD. While stocks made their bottom in March, AUD held its late 2008 lows and proceeded higher, with peaks roughly corresponding to those in stocks: a relatively flat corrective period into early July, a push to new highs, and most recently rangebound trade.

Which is why, when I saw stocks (ES futures; second chart from top) break below their multiday range this morning, I was particularly interested to see a smart snapback rally in AUD/USD (third chart from top). A five-minute chart that's a little broader (bottom chart) shows that AUD/USD actually moved nicely above yesterday's highs.

These are the kinds of little tells I look for in handicapping whether risk assets will be coming back into favor vs. rolling over. I thought the snapback in stocks, led by currency snapbacks vs. USD, was a point in favor of the equity bulls..

Above we see a one day and one week tracking for the groups. Note how "Basic Materials", which in their scheme includes both oil-related and other raw materials stocks, has been lagging in performance, mirroring commodity weakness. That commodity weakness, in turn, has been sensitive to lagging performance in emerging market stocks and currencies.

I'm watching this theme carefully, as the emerging market story--and aggressive emerging market stimulus--has led the risk rally since March..

We've broken below the overnight lows from 8/25, as risk aversion themes--selling in commodities, buying of Treasuries, buying USD--are weighing on stocks (ES futures above). Selling pressure is significant, with no NYSE TICK readings even making it to +500 so far this morning. I am watching to see if we accept value below those 8/25 lows; if so, we're setting up a short-term downtrend, which is following the many non-confirmations that I have been blogging about..

Note that bond prices plunged during the late 2008 crisis, as investors fled riskier debt and sought safe haven in Treasury instruments. Interestingly, one tell for the market bottom in March was the fact that we made new lows in high yield bond prices, but not investment grade.

Since that time, investment grade bonds have steadily moved higher, retracing much of their decline from 2008. High yield bonds have retraced only a portion of their total declines, but note that their percentage gain from the March lows has been higher than that for investment grade bonds. This, like the rally in emerging market equities, is an example of how we have seen riskier assets lead the way during the 2009 recovery.

Most recently, the new highs in LQD have not been confirmed by JNK. That is just another one of the non-confirmations on my radar, as riskier assets have recently underperformed safer ones. I am watching these intermarket themes closely to see if the dynamics of the market recovery are changing or if this is simply an August pause that refreshes the risk rally..

Many thanks once again to Damon Pavlatos and FuturePath Trading for hosting my recent webinar on best practices for traders. I know many traders could not attend the live event; thanks to FuturePath, the archived presentation is now available. Alternatively, you can find the link on the right side of FuturePath's home page.As always, I appreciate the interest. I look forward to the next free webinar, hosted by IOAMT. I'll have registration info posted shortly.Brett

Wednesday, August 26, 2009

* MARKET THEMES FROM WEDNESDAY: We registered an inside day today, with lower price highs and higher price lows relative to Tuesday. This sustains us in a multi-day trading range. During the range, we've seen the U.S. dollar trade higher vs. the euro and weakness in gold and oil, both of which closed off their lows. We've also seen a drop in 10-year Treasury yields, consistent with the theme of profit taking in risk trades. New 20-day highs across the NYSE, NASDAQ, and ASE fell to 802; new lows were 248. The great majority of stocks in my basket continue to trade in short-term uptrends. The longer we stay in the trading range, the more we're accepting value at the higher price levels, which is consistent with a continuation of the bull move in spite of nagging non-confirmations. A drop below the price lows of last week would clearly negate that bullish scenario. I will be updating indicator readings as usual via Twitter (follow here).

* How do you manage positions most effectively to get the most out of trade ideas?

* How do you most effectively manage yourself and your emotions during trading?

* How do you prepare for market days most effectively?

* How do you best review markets and trading performance for optimal learning?

What I find is that the traders who have been successful over the long haul know the answers to these questions and also have very distinctive answers.

Like Toyota or UPS, they have developed their own, unique processes that are both efficient and effective. Success is a function of refining processes over time and becoming ever more consistent in following those processes.

If you *know* your processes, you can more readily develop confidence in them. Many times that is the difference between making the good trade and not; avoiding the bad trade and not.

Half of the challenge of trading is finding your best practices; the other half is implementing them with fidelity and consistency.

Hats off to a couple of readers, who noted my earlier heat map post and commented on the value of the heat maps and market data found on the FinViz site. Above we see a snapshot of just two sectors from a much larger map. Note how the stocks that are most highly weighted in the sectors have the largest boxes. The boxes are shaded red if the stock is down; green if up; and grey if neutral. The map allows a quick look at the colors of each sector, but also is organized by subsectors. This enables you to see if strength or weakness within the sectors is more general or mixed.

I will have more to say about FinViz in an upcoming post. The value here is in condensing a large amount of information into a clear display that facilitates quick processing and action. .

With USD trading stronger and oil and gold weaker and 10-year Treasury yields on the decline, the risk themes are aiming more toward risk aversion, and that has stocks trading at the lower end of their recent range (ES futures; chart above). Note continued heaviness in emerging markets (EEM); that, along with commodity weakness, continues to raise yellow flags for me longer term..

If you read my post on transition patterns in the market, you'll see why I'm a nervous bull. While the sectors are quite strong and we're seeing new advance-decline line highs, the new highs in the S&P 500 Index (SPY; top chart) remain unconfirmed by a number of sectors and indexes. While emerging markets (EEM; bottom chart) were the drivers for the rally since March, they have failed to make new highs recently.

What suggests to me that this may not be an isolated phenomenon is that commodities (DBC) have also failed to make new highs and commodity-related sectors (XLB, XLE) have not confirmed new highs in the S&P 500 Index. If growth and commodity demand won't come from the emerging nations, it is difficult to believe that the slower growing developed markets will sustain the bull.

Yet other non-confirmations come from the number of stocks registering fresh 20- and 65-day highs. Those peaked in July and are notably lower during the recent market highs, suggesting that fewer issues are participating in the index strength. That's usually not a recipe for ongoing market strength.

It also raises the possibility that we saw a momentum high in July, a stiff pullback last week, and now price highs on lower participation. If this is, indeed, a larger timeframe transition pattern in the making, we should fail at these highs and begin a sharp pullback that would take us below the lows of last week.

While I stick with my short-term indicators, such as Cumulative TICK and Demand/Supply, and those are bullish, the larger picture non-confirmations leave me nervous and ready to reverse views. We need to see day-over-day strength here, confirming the bull move. Expanding new 20-day lows would be an important indication that all is not well for the bull. Expanding 20-day highs would be important support for the bulls. As always, I'll be updating indicators via Twitter (free; subscribe/follow here).

Tuesday, August 25, 2009

* MARKET THEMES FROM TUESDAY: We saw a rangebound market on Tuesday, as early strength reversed and pulled us into a two-day trading range. Oil was weak, but not a lot of movement in the U.S. dollar, and 10-year Treasury rates stayed below 3.5%. New 20-day highs across the NYSE, NASDAQ, and ASE dipped to 1381 against 212 lows. While the new highs remain non-confirming of recent price highs (an issue of some caution for me), new 20-day lows have not expanded to the point where it appears that we're rolling over. Note that we've also seen new bull highs in the advance/decline lines specific to S&P 500 stocks and to NYSE common issues only. Indeed, we've had more advancing issues than decliners for five of the last six trading sessions.

One of my favorite trading setups is what I call the transition pattern. It is a reversal pattern that occurs in several distinct phases, and it occurs across multiple time frames. In this example, we're looking at a five-minute chart from today's ES trade.

Transition patterns set up very nicely in Market Delta, because volume--and its distribution--is an important part of the sequencing. Just a quick rundown for those unfamiliar with Market Delta: within each bar, at each price, is the volume traded when that price was the market bid vs. the volume traded when that price was the market offer.

If the volume transacted at the offer exceeds that at the bid, then the interior of the bar is shaded green; if the reverse, it's shaded red. This tells us, at each time and price, how much business was getting done and how much of the business was attributable to buyer aggressiveness (transactions at the offer) vs. seller aggressiveness (transactions at the bid).

In the bottom histogram, the net volume transacted at bid vs. offer for each time period is charted. If the histogram bars are green, it means that more volume was transacted at the market offer than the bid at that time. Red bars mean that, for that five-minute period, more volume was transacted at the market bid than offer.

The transition pattern for an upside reversal begins with a momentum high, in which price moves higher on strong volume and strong volume transacted at the market offer. If you click on the chart above, you'll see the short-term momentum high labeled.

Following the momentum high, we typically get a pullback that is a bit surprising in its extent: the high prices bring in a decent degree of selling. Once the selling abates, we renew the uptrend and typically make a new, price high. This price high occurs on lower volume than the momentum high and less volume at the offer vs. bid. This tells us that higher prices are no longer facilitating trade: the auction is shutting off. The price high is labeled in the chart above; note the weakened volume.

Following the price high is a pullback that is almost always more severe than the first one, as it typically retraces the most recent move to new highs. Volume expands, but this time it is dominantly volume transacted at the market bid, as former buyers are scrambling out of their positions. Note on the chart above how volume expands to the downside with the reversal.

Sometimes we get a weak push up following that second reversal; that push does not result in new price highs, but is a part of the overall topping, reversal process. In that event, the transition pattern can take on a head-and-shoulders quality. Not all transitions, however, look like head-and-shoulders formations. The important elements are the drying up of volume to the upside, the false upside breakout, and then the scrambling of the longs out of their positions, adding downside volume.

As a very rough rule, the longer the time period separating the momentum and price highs, the deeper and more protracted the subsequent reversal. That makes sense, because when we have extended topping, more bulls are ultimately trapped and contribute to the eventual downturn. When we get transition patterns on daily or weekly charts, the reversals can be quite important: witness the momentum lows in late 2008, the price lows in March, 2009, and the upside reversal that we're now seeing.

IMO, one could probably make a living trading nothing but this pattern across instruments and time frames--particularly if you integrate the pattern with price and volume patterns from Market Profile. That would be a fun experiment...

Here's a nice, quick way to track intermarket themes; major props to the excellent Barchart sitefor these futures market heat maps. Above is the heat map for 12:50 PM CT and then the map from an hour later. The map shows how major asset classes are moving relative to one another; by tracking the map over time, you can see which groups are receiving buying and selling interest.

Note how stocks are range bound today and how we see very little in the way of directional intermarket themes on the day. Oil is down, stocks retraced earlier strength, the dollar and interest rates are little changed, and--overall--there's not much volatility to the numbers. This is one excellent tell for a range day: if correlated markets aren't trending, stocks often won't find distinctive buying or selling interest..

We can see from the 30-minute chart of the ES futures that we have been consolidating in a range since breaking out to bull highs on Friday and adding to those gains early on Monday. Note that we're continuing to trade above Friday's breakout point, which means that we're accepting value at this higher level. One of the best indicators I know that differentiates false breakouts from the real deal is simply time. If a market is going to spring a trap for bulls, it will reverse relatively promptly and force the covering of positions. The longer we spend in a new range, the more likely it is that participants have accepted value there and we will stay there as a new valuation.

So far, pullbacks in stocks have been relatively short and shallow. Money managers cannot be caught without positions in a recovering market. As long as that dynamic persists, we should see pullbacks at successively higher price levels and a willingness to accept value on upside breakouts..

One worthwhile exercise is to review your good trades and identify what made them good. What you'll find are some of the "rules" that comprise your best trading: the best practices that contribute to your success. By reverse engineering your good trading, you make rules your rules explicit. Once they are explicit, you can mentally rehearse them, work on them as daily trading goals, and consciously apply them in the future.

1) Trade in the direction of intraday sentiment, as captured by NYSE TICK and Market Delta;

2) Start with profit targets: range extremes, pivot prices, and R1/R2/R3 and S1/S2/S3 targets. First figure out where you think the market is likely to move.

3) Execute the trade on a pullback in intraday sentiment: a drop in TICK during an uptrend; a bounce in TICK during a downtrend. Don't chase price highs or lows. Make the market show you that it is making a higher low (uptrend), a lower high (downtrend), or holding support/resistance (range).

4) Put your stop loss level far enough away that it won't be hit by random noise; that, if it's hit, it will tell you clearly that you're wrong. Size the position small enough so that you can readily weather getting stopped out.

5) Don't get into a trade unless you have at least 1:1 risk/reward to the first profit target and meaningfully higher to subsequent targets.

6) Enter your position with enough size so that you can take a piece off at your first profit target and still meaningfully participate in a further move in your direction. Enter your position with small enough size so that you can add to the trade if it proves particularly strong. If things look dicey at your first profit target, don't hesitate to take quick profits.

7) Don't look back while you're trading and second guess yourself; reviewing comes after the closing bell. Identify any lessons you've learned from your trade, but keep focused on fresh opportunity once you've closed a position.

I have other rules, of course, but these are some of the important ones illustrated by the trade I posted. Over time, I'll post other trades--including losers--to illustrate other rules.

The idea is not for your rules to match mine, but rather for you to become more aware of the rules that contribute to your success, so that you can become more consistent in following them.

About Me

Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), and The Daily Trading Coach (Wiley, 2009) with an interest in using historical patterns in markets to find a trading edge. I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014, along with regular posting to Twitter and StockTwits (@steenbab).